WARNING !!!! WORLDWIDE WIPEOUT AHEAD !!!!

Warning: Worldwide wipeout ahead
Think U.S. stocks are on a life raft? Look around the globe, where seas are much rougher. This is serious, folks. Brace for a brutal riptide of more economic upheaval.

By Jon Markman
August 22, 2008
It barely seems possible that anyone is more pessimistic about corporate earnings prospects than American shareholders right now, with the U.S. stock market down almost 15% for the year and the banking system coming unglued before everyone's eyes.

Yet if you take a moment to look around the world, you may be surprised to learn that U.S. stocks are the picture of health compared with their counterparts worldwide. And measured against the gloom in bonds, U.S. stocks are like a sunny day in spring.

Time to gloat? Not on your life. For if there's one thing we know about global markets these days, it's that they seldom diverge for long. So while it might be tempting to look with pity at investors across the seas and in other asset classes, it's more likely that U.S. equities will plunge than that foreign equities will float higher toward our perch.

Just spin a globe to see a few examples from the world of truly Olympian value destruction:

* The British stock market has been harried down the rabbit hole to the tune of 22%, or about half again as bad as we have it. Blame energy, banking and telecoms, because those are the downside leaders for the Europeans, particularly basket cases such as wireless giant Vodaphone Group (VOD.N), down 30%, and Royal Bank of Scotland (RBS.N), down 44%.

* The French market is also une grandestinque-bombe, down 22%, led by energy and banks. The Belgian market is worse, down 30%, with Germany down 24%, Austria down 23%, the Netherlands down 21% and Spain down 23%.

* Elsewhere on the Continent, the news does not improve. Sweden is off 23%, Russia is down 23%, Turkey is down 25%, and Greece is down 36%.

* How about Asia, the crown jewel of global growth? It's a wet noodle. The Chinese market is down 31%, South Korea is down 27%, once-hot Malaysia is down 29%, and India is down 43%. The best in the region are down half as much but still a lot, as Japan has lost 16% of its value this year. Taiwan is off 14%, Australia is off 21%, and Singapore is down 19%.

* And Latin America, that bastion of energy, metals and grains? Well, the bear market in Brazil has only just begun; it is down just 12% so far after being up as much as 22% in mid-May. Mexico is hanging in there at 5%, probably propped up by the narco-trafficking biz. But Argentina has fared a lot worse, sinking 20%.

Most of the European and Asian countries' biggest companies are banks that have suffered the same fate as U.S. financial institutions. Gullible and desperate for income at a time of record-low yields in the mid-2000s, they were suckered by Wall Street investment banks into borrowing to the hilt to buy high-yielding mortgage-backed securities that were mislabelled as high-quality, low-risk investments.

It takes only a 4% loss to wipe out your capital when you're at leverage levels of 30-to-1 -- a measure of how much capital you have at risk compared with how much capital you have before borrowing -- as many banks around the world were. And add to that a crash in metal and energy prices in the past two months, plus a slowdown in industrial growth, and you have a conflagration of capital that knows no borders.

The global dominoes fall
You need read only a single day's worth of headlines to gather that a global, synchronized economic wipeout is under way. On Aug. 18, Bloomberg reported that:

* French manufacturing confidence fell in July to the lowest level in five years.

* New Zealand's services industry contracted in July for the fourth straight month.

* Sales at Japanese department stores fell in July for the fifth straight month.

* Singapore's overseas shipments dropped in July for the third straight month as companies shipped fewer electronics and drugs to customers in the West.

In many places, a perfect wave of growth has reversed into a brutal riptide. Indian information-technology companies such as Cognizant Technology Solutions (CTSH.O) and Wipro (WIT.N) swelled in importance by helping U.S. companies fix the "millennium bug" in the late 1990s and then went on to grow at 40%-plus rates as the tech outsourcing fad exploded.

Now, The Wall Street Journal reported this week, the Western credit crunch and capital expenditure slowdown have sapped sales, and the cheaper U.S. dollar has shrunk Indian tech company profits. At the same time, rising labour costs have permitted competition to emerge in lower-cost countries in Eastern Europe and the Philippines. The big Indian tech companies' shares are down 30% in the past 10 months versus a negative 18% for U.S. techs.

Meanwhile, fear has gripped corporate bond investors by the throat in ways that make stocks' problems look tame. Surely you remember bonds, those widows-and-orphans instruments that were once considered the market's equivalent of a boring IOU, paying a percentage point or two above U.S. Treasurys? Well, now many are trading like penny stocks.

You can call your broker to buy debt by the mortgage unit of blue-chip GMAC Financing at crash-landing prices that would give you a 50% annualized rate of return over the next three months when they mature in November. Or perhaps you'd prefer bonds of privately held plastics giant Pliant that mature in September 2009 and are going for 45%. Or bonds of car-parts maker Dayton Superior (DSUP.O) that mature in June 2009 for a yield of 40%. Or maybe Washington Mutual (WM.N) bonds maturing in January that trade around 35%.

I could go on and on. Credit analyst Brian Reynolds has sent clients a list of 60 major companies with bonds maturing over the next 12 months that trade with yields over 10% at a time when the U.S. federal funds rate is at 2%, adding in a note: "And these are just the bonds that have been able to trade!"

The Merrill Lynch Corporate Master Index, which tracks the performance of investment-grade-rated corporate bonds, shows 72 of them trading in "distressed" condition, or more than 10 percentage points over U.S. Treasurys -- 28 of them issued by banks such as regional giants National City (NCC.N) and Washington Mutual. That means corporate bankruptcies are virtually inevitable over the next 18 months. Chris Whalen, the managing director of Institutional Risk Analytics, has told Dow Jones Newswires that he expects 110 banks with $850 billion in assets to fail by next July, which is eight times the Federal Deposit Insurance Corp.'s reserves.

A spate of bankruptcies of this breadth is incompatible with a rising stock market even if the next president gets in front of the problem by creating a new government entity that buys failed banks, much like the Resolution Trust Corp., which closed 747 thrifts starting in 1989. So either the pessimistic credit guys and global-equity investors are terribly wrong right now, or the relatively optimistic U.S. equity investors are wrong. They can't both be right, as both depend on assessments of global earnings potential, with small variation for currency values.

Since credit has led the recent cycle down, and since the rest of the world's vote is overwhelming, I think we have to give a nod to the pessimists this time. The latest bounce should persist a little longer, but once the Dow Jones industrials ($US:INDU) climb to around 12,000 by early fall, watch out below.


[link to finance.sympatico.msn.ca]


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